Rules, low demand hinder Malaysian Basel III sukuk

Reuters

By Bernardo Vizcaino and Al-Zaquan Amer Hamzah

KUALA LUMPUR, Sept 23 (Reuters) - Malaysia is in many waysone of the world's leading Islamic financial markets, butregulatory issues and comfortable balance sheets are causing itto lag behind the Gulf in one innovation: capital-boostingsukuk.

Since last year, Gulf banks have been developing sukukdesigned to increase their capital, in order to meet new BaselIII banking standards due to be phased in around the world overthe next several years.

In November 2012 Abu Dhabi Islamic Bank issued ahybrid sukuk, one with equity-like characteristics, to boost itsTier 1 capital. Dubai Islamic Bank sold a similar $1billion instrument in March 2013.

There have also been subordinated sukuk issues to raise Tier2 capital, including a 1.4 billion riyal ($373 million) sale bySaudi Hollandi Bank last November. Saudi British Bank, which issued a Tier 2 sukuk in March 2012, aims tosell another one by the end of this year.

Within Malaysia, conventional banks have been among thefirst institutions in Asia to move to issue Basel III bonds;CIMB Group Holdings sold one this month, raising 750million ringgit ($238 million) of Tier 2 capital. Public Bank and RHB Investment Bank have preparedsimilar bond programmes.

But so far no Islamic bank in Malaysia has established aprogramme to issue capital-boosting sukuk - partly because theysee no strong need, bankers say.

"You find that in Malaysia most of the banks are fairlycomfortable, with some banks more capitalised than others," saidBadlisyah Abdul Ghani, chief executive of CIMB Islamic Bank, thesharia-compliant unit of southeast Asia's fifth-largest lenderby assets.

"At the earliest you will probably see - perhaps next year -some banks going to market, but most will not really be in themarket because they are well-capitalised."

LOSS ABSORPTION

Although subordinated debt is more expensive for issuersthan secured debt, strong demand among local investors in theGulf has allowed banks there to sell Tier 1 and Tier 2 sukuk atprices they find favourable.

Regulation is one factor encouraging such issuance. Althoughnational financial regulators in the Gulf have not yet fullyclarified how they will apply Basel III standards, bankers inthe region expect local versions of Basel III will not include aloss absorption feature allowing regulators to convert debt intoequity if an issuer faces insolvency.

This is particularly true in the United Arab Emirates.Because of their large state budget surpluses and lack ofbroad-based income taxes, Gulf governments do not see that muchof a need to protect taxpayers from bank crises withloss-absorption clauses.

Malaysia's version of Basel III does require lossabsorption, however, which could raise costs for the issuer of asubordinated sukuk.

Islamic banks in Malaysia are still studying how to includethe clauses, so the timing of the first Basel III sukuk remainsuncertain, said Leon Koay, head of global markets and co-head ofwholesale banking at Standard Chartered Malaysia.

"There are a lot of challenges of dealing with the point ofnon-viability. There's an evolution there of how they want toget the structure right."

Even with loss absorption, Malaysia's sukuk market is deepand liquid market enough for banks to manage any additionalpremium required by investors, said CIMB's Abdul Ghani.

"Margins in Malaysia are very tight, so I don't think itwill really influence much in regards to cost."

But for now at least, Malaysia's Islamic banks see littleurgency to raise capital. The central bank requires all banks tohave a core equity Tier 1 capital ratio of 4.5 percent ofassets, a Tier 1 capital ratio of 6 percent and a total capitalratio of 8 percent of risk-weighted assets by January 2015.

Malaysian banks in general are so well capitalised that theycould sustain a 300 percent rise in non-performing loans withoutTier 1 common equity falling below 7 percent, Moody's InvestorsService estimated in a report earlier this year. Islamic banksare especially comnfortable.

In the meantime, several Islamic banks in Malaysia areexploring the possibility of using alternative means to sukukissues to handle their Basel III capital needs, said a bankerwho declined to be named as the matter is not yet public.

The alternatives could include the issuance of sukuk orother financial instruments by government entities; theseinstruments would be purchased by Islamic banks and, if theywere government-guaranteed or structured to have very low oreven zero risk-weightings, could improve the banks' capitalratios, the banker said. (Editing by Andrew Torchia)

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